Review of Financial Panics

Review of Financial Panics Financial Panics, events during which bank depos itors attempt to withdraw their depos its , equity holders s ell s tock, and market participants in general s eek to liquefy their as s ets . Panic of 1785 The panic of 1785, which las ted until 1788, ended the bus ines s boom that followed the American Revolution. The caus es of the cris is lay in the overexpans ion and debts incurred after the victory at Yorktown, a pos twar deflation, competition in the manufacturing s ector from Britain, and lack of adequate credit and a s ound currency. The downturn was exacerbated by the abs ence of any s ignificant inters tate trade. Other factors were the Britis h refus al to conclude a commercial treaty, and actual and pending defaults among debtor groups . The panic among bus ines s and propertied groups led to the demand for a s tronger federal government. Panic of 1792 The panic of 1792 aros e from s peculative activity following the adoption of the Federal Cons titution, the founding of the Firs t Bank of the United S tates (BUS), and the emergence of s ecurities markets for bank s hares and other government s ecurities in New York City. Almos t immediately after its es tablis hment in 1791, the BUS overextended notes and dis counts, and then s harply revers ed its cours e. S peculators in the bank's s hares quickly s old their holdings , which had ris en markedly over previous months, and the nation's firs t true s ecurities market panic took hold. Panic of 1819 The S econd Bank of the United States , s eeking to curb s peculation in commodities and wes tern lands following the War of 1812, s harply contracted its extens ion of credit, provoking the panic of 1819. The downturn hit the s outhern and wes tern s tates hardes t, and many banks s us pended s pecie (coin money) payments or clos ed their doors . The BUS went through a period of recrimination, congres s ional inves tigation, and financial rehabilitation. Commodity prices declined, manufacturers clamored for more protection, and debtors demanded relief legis lation, which was enacted in s everal wes tern s tates . The economic picture had improved by 1823. Panic of 1837 A s eries of events led to the panic of 1837: On 11 July 1836, Pres ident Andrew Jackson is s ued an executive order (the S pecie Circular) that attempted to end s peculation in wes tern lands by requiring s pecie for their purchas e; the Depos it Act, pas s ed on 23 June 1836, ordered that the more than $34 million in s urplus that had accumulated in the Treas ury be redis tributed to the s tates , in proportion to their relative populations ; the S econd Bank of the United States dis s olved following Jacks on's veto of an act to recharter in 1832; and England introduced a tightened monetary policy des igned to "recover" s pecie pres umed los t to the United S tates . By early 1837, thes e factors had dis located the nation's s pecie res erves out of New York City and into the interior and the hands of the public. With its s pecie bas e depleted by more than 80 percent over a s ix-month period, the public los t confidence in the New York banks and withdrew their depos its. Within two weeks, all of the nation's banks had s us pended s pecie payments. This firs t general s us pens ion in the nation's his tory s tarted a s ix-year economic downturn that was the mos t s evere of the nineteenth century. Panic of 1857 The failure of the Ohio Life Ins urance Company in Augus t 1857 was the catalyst that initiated the panic of 1857, which s pread quickly from the Ohio Valley to the eas tern money centers . Unemployment grew, breadlines formed, and ominous s igns of s ocial unres t appeared. The depres s ion was mos t s erious in the indus trial northeas t and in the wes tern wheat belt, where the new Republican Party s aw increas ing s upport. The cotton belt was les s affected by the panic: cotton crops were good, prices were high, and banks were s ound. Thes e factors brought over-confidence in the S outh, an impuls e to protection in the Eas t, and a drive for free land in the Wes t. Economic conditions became as potent an is s ue as s lavery in the s ubs equent election of 1860. Panic of 1873 The failure of s everal important eas tern firms in S eptember 1873—including the New York Warehous e and S ecurities Company; Kenyon, Cox and Company; and the famous banking hous e, Jay Cooke and Company—precipitated this panic. The s tock exchange clos ed for ten days , and bankruptcy overtook a hos t of other companies and individuals . S ome caus es of the panic and ens uing depres s ion were international, including a s eries of wars and exces s ive railroad cons truction in central Europe, Rus s ia, S outh America, and the United S tates . Domes tic factors included currency and credit inflation, los s es from fires in Bos ton and Chicago, an advers e trade balance, and overinves tment in railroads , factories , and buildings . In the following depres s ion, 18,000 firms failed during 1876 and 1877, a majority of the American railroads declined into bankruptcy, and more than two-thirds of the nation's iron mills and furnaces fell idle. Wage reductions led to s trikes among Penns ylvania coal miners and New England textile workers , and to a railroad walkout in 1877. In 1878 the depres s ion began to lift. Panic of 1893 The panic of 1893 originated in the us ual factors of the bus ines s cycle, including overinves tment and falling prices in the 1880s . The uneas y s tate of British s ecurities markets in 1890—culminating in the liquidation of the banking hous e of Baring Brothers and Company—s topped the flow of foreign capital into American enterpris e, and the s ale of European-held s ecurities caus ed a s tock market collaps e in New York, accompanied by s ubs tantial gold exports . The financial cris is was pos tponed, however, by s trong exports of agricultural s taples over the next two years that rees tablis hed gold imports . Uncertainty returned in the winter of 1892–1893 as renewed gold exports rais ed the pos s ibility that the nation would be forced off the gold s tandard by a decline in the U.S . Treas ury's holdings . The nation als o s uffered with decreas ed federal revenues and heavy expenditures , including the purchas es of s ilver under the Sherman S ilver Purchas e Act of 1890. The gold res erve had fallen below the accepted minimum of $100 million by April 1893, and the failure of the National Cordage Company in May touched off a s tock market panic. By the end of 1893, about 4,000 banks and 14,000 bus ines s es had failed. Pres ident Grover Cleveland s ought a repeal of the S ilver Purchas e Act as the one abs olute cure for the depres s ion. By 30 October the repeal had pas s ed both hous es of Congres s . In the meantime, imports of gold had s tabilized the monetary s ituation in New York s omewhat. The depres s ion did not lift s ubs tantially, however, until the poor European crops of 1897 s timulated American exports and the importation of gold. Panic of 1907 Sometimes called the "rich man's panic," the panic of 1907 was preceded by s peculative exces s es in life ins urance, railroad and coas tal s hipping combines , mining s tocks , and inadequately regulated trus t companies . S everal profit-dampening reforms were enacted in 1906, s uch as the Hepburn Act (giving the Inters tate Commerce Commis s ion power to s et maximum railroad rates ) and the Pure Food and Drug Act, yet the economy s eemed healthy in January 1907. In fact, mos t financiers believed that improved banking controls made it impos s ible for panics like thos e of 1873 and 1893 to recur. In early 1907, when Henry H. Rogers of S tandard Oil had to pay 8 percent interes t to float a $20 million bond is s ue, the s tock market dropped s harply—the s o-called s ilent panic. The economy s eemed to recover, but failure of the United Copper Company in the s ummer of 1907 precipitated runs on the Heinze and Mors e chain of banks. When the Knickerbocker Trus t Company clos ed in October, runs on the Trus t Company of America and s everal others followed, and there was panic on the s tock market. To halt the panic, Secretary of the Treas ury George B. Cortelyou authorized large depos its in s everal banks . Inves tment banker J. P. Morgan headed a banking group that us ed a borrowed emergency fund of nearly $40 million to res cue banks and firms they deemed s avable, and whos e s urvival was crucial. To res cue the brokerage hous e of Moore and S chley, Morgan arranged to have the United S tates S teel Corporation buy the brokers ' holdings of the s tock of a major rival, the Tennes s ee Coal, Iron, and Railroad Company. This arrangement s trengthened the s teel trus t. By the end of the year, the financial s ituation was normal again. Although the panic did not lead to heavy unemployment or a wave of bankruptcies , it s erious ly damaged the image of the big financiers . It als o had repercus s ions over-s eas , as the United S tates temporarily imported a large amount of gold, and interes t rates abroad ros e. On 30 March 1908, Congres s pas s ed the Aldrich-Vreeland Currency Act, which provided for contingency bank currency in the event of another s tringency. The act als o created the National Monetary Commis s ion, which produced the Aldrich Report of 1911. This was a major s tep in s etting up the Federal Res erve S ys tem in 1913–1914. Panic of 1929 The panic of 1929 had many caus es , mos t importantly annual private and corporate s avings in exces s of the demand for real capital formation, a large export trade in manufactured goods s upported by foreign lending, a low dis count Federal Res erve policy des igned to s upport the Britis h pound, and increas ing us e of s tock-exchange s ecurities rather than commercial paper for bank loans . The period of pros perity from 1924 to late 1926 had been largely aided by buying cons umer durables in ins tallments, particularly automobiles , real es tate, and cons truction. When the automobile indus try became temporarily s aturated in 1927, a downturn was to be expected, but the cons truction boom s howed s urpris ing vitality until mid-1929. The Federal Res erve purs ued a relatively eas y monetary policy, and exports continued to be buoyed up by foreign lending. When opportunities for real inves tment s agged after 1926, top-income inves tors poured cas h into the s tock, bond, and mortgage markets. Banks made large loans on the s ecurity of blocks of the common s tock of a s ingle company to keep their depos itors ' money employed. By June of 1929, s ome bankers had become alarmed by the continued ris e of the s tock market, and in Augus t the Federal Res erve rais ed the dis count rate. This move attracted more domes tic and foreign capital into the call loan market, thus applying a final las h of the whip to the runaway boom in s ecurity prices . The s tock market peaked right after Labor Day, but on Friday, 18 October, it began to decline rapidly; 29 October was the mos t devas tating day in the his tory of the s tock exchange. Yet during the month-long decline, the S tandard and Poor Index fell by les s than 40 percent, and public s tatements held that no harm had been done to normal bus ines s . Uns een factors that led to the nation's deepes t depres s ion, however, were large bank loans that could not be liquidated and the accompanying pres s ure of failed banks on healthy ones , the collaps e of European finance in 1931, a monetary policy by the Federal Res erve that vacillated between meeting domes tic and foreign needs , and the lack of any large capital-cons uming technological development to re-s timulate private inves tment. Bibliography